Standing Committee D

[Mr. Eric Illsleyin the Chair]

Clause 540

Exercise by directors of power to allot shares etc

Question proposed, That the clause stand part of the Bill.

Eric Illsley: With this it will be convenient to discuss the following: clauses 541 to 592 stand part, Government new clauses 45 to 160, Government new clauses 162 to 240 and Government new clauses 412 to 416.

Vera Baird: Good morning, Mr. Illsley. We propose that parts 18 and 19, which deal with the allotment of shares and share capital generally, should be completely replaced as part of the restatement exercise. Assuming that the Committee agrees to the changes, I intend to oppose clause 540 standing part, and similarly to oppose the Question on clauses 541 to 592.
The Government new clauses replace clauses 540 to 592, with the following exceptions: those elements of clause 583 relating to the allotment of debentures and the transfer of shares in debentures; clause 584, which will be restated in the new clauses dealing with debentures and transfer of securities; and clause 585, which is being restated in the new clause dealing with distributions.
In addition, the new clauses restate various provisions of the Companies Act 1985. Without exhaustively listing them, they relate to the allotment of shares, alterations to a company’s share capital, variations of class rights, reductions of share capital, shares no bar to damages, serious loss of capital, general rule against acquisition of own shares, financial assistance, redeemable shares, purchase of own shares, Treasury shares, capital redemption reserves and various associated provisions, and provisions relating to the persons who may be appointed to conduct valuation of non-cash assets.
As we explained when debating clause 675 stand part, this restatement exercise has necessarily resulted in some reordering and restructuring of parts 18 and 19. In some cases, the new clauses are different in structure from their counterparts in the Bill, but our starting point is the restatement exercise. We are not making substantive changes in the law unless they are needed to ensure that the restated provisions are compatible with the other provisions of the Bill. However, a small number of changes to provisions that are restated have been required to ensure compatibility with European Union law. A very small number of changes are also required to give effect to what would have been Government amendments to existing clauses had the clauses in question not been restated in the new clauses in this group. I shall turn to those and take hon. Members through them.
First, we have removed the requirement imposed in clause 582 for a private company that makes a purchase of own shares out of capital to file a statement of capital with the registrar. It is unnecessary because such a company is already under an obligation to file a statement of capital when buying its own shares; there is no need for an additional requirement.
Secondly, we have taken the opportunity in the restatement of what are currently clause 561 about the reconversion of stock into shares and clause 589 concerned with the form of notice that must be given to the registrar, when a company has redenominated its share capital, to clarify that the requirement applies only to limited companies.
Finally, clauses 414 and 415 restate the law on the independence of persons required to value non-cash assets, for example in connection with an allotment of shares by a public company. The new clauses have the same effect as section 108 of the 1985 Act, but spell out the full statutory auditor qualification requirement rather than cross-referring to the statutory auditor provisions to be restated in part 35 of the Bill.
We are seeking power to make changes to some of the restated provisions in the group, in particular the provisions on capital maintenance, which have been foreshadowed in debates in the other place. I shall say more about that when we debate clauses 161, 241 and 306. It is the largest group of restated provisions and we are clearly not expecting members of the Committee to consider the issue in detail now. As we said during the debate on clause 675, we shall be consulting interested parties on the new clauses during the summer with the limited purpose of making sure that we have not made any unintended changes to the law. None the less, it is an important job that must be done and we are grateful that the Law Society, in particular, has offered its assistance.
On the basis that there will be further opportunities to amend the restated provisions, if necessary, will members of the Committee lend their support to our approach to the restatement exercise and vote in favour of the amendments in new clauses 45 to 160, 160 to 240 and 412 to 416 when we reach them? On the assumption that that will happen, I ask them to oppose clause 540 and clauses 541 to 592 standing part of the Bill.

Jonathan Djanogly: We have now reached part 18 and the Minister has set out how the Government intend to deal with the new clauses. I have set out our party’s position and I shall not repeat our general stance. It will, in effect, equate to our abstaining on the votes on the basis that we shall need the summer to consider the new clauses and take advice on their implications.
As for part 18, of all the various parts, consolidation is as welcome there as anywhere. There is no doubt that, when practitioners complained about the lack of consolidation it was often the fact that the allotment provisions would be in one piece of legislation and the pre-emption provisions would be in another piece of legislation that was the upsetting aspect of non-consolidation. To that extent, the general move is welcomed and we can discuss some more specific aspects as we proceed.

Quentin Davies: On a point of order, Mr. Illsley. I am confused about how we are to proceed this morning. If the Government intend to vote against clauses 540 to 592 standing part, are we to debate the amendments to them first and then vote on the clauses standing part in a block at the end? Is that to be the procedure?

Eric Illsley: The Government intend to negative clauses 540 to 592. The selected amendments will be debated as we progress through the morning.

Question put and negatived.

Clause 540 disagreed to.

Clause 541 disagreed to.

Clauses 542 to 553 disagreed to.

Clause 554

Commissions, discounts and allowances

Jonathan Djanogly: I beg to move amendment No. 529, in clause554,page267,line3,leave out ‘conditions are’ and insert ‘condition is’.

Eric Illsley: With this it will be convenientto take the following amendments: No. 530, in clause554,page267,line8,leave out ‘conditions are’ and insert ‘condition is that’.
No. 528, in clause554,page267,line10,leave out paragraph (b).
No. 532, in clause554,page267,line12,at end insert ‘or
(iii) the amount or rate approved by members,’.
No. 531, in clause554,page267,line13,leave out ‘less’ and insert ‘least’.

Jonathan Djanogly: We now move on to commissions, discounts and allowances. The clause deals with companies paying commission, and states that the payment must be authorised in the articles and must not exceed 10 per cent. of the share issue price. In practice, the provision, which seems to have been around for ever and a day, has little purpose in this day and age. If a company wants to get round it in its commission arrangements with, say, an investment bank on a placing, in addition to the 10 per cent. commission a corporate finance fee could be charged, effectively topping up the amount paid to the stockbrokers doing the placing.
More to the point, if there is to be a cap on commission, what is the relevance of the figure of 10 per cent? In the Lords Grand Committee, Lord Sainsbury simply said words to the effect that the provisions had been around for 100 years and the Government were not persuaded to change them. I see some merit in making it necessary for commission payments to be authorised in a company’s articles, but not in making it necessary to operate a cap on the amounts payable. On that basis, we have tabled our preferred amendment No. 528, which would delete the requirement for a cap on commission. As a second preference we have tabled amendment No. 532, which provides for the cap to be overruled with the specific approval of the company’s members. In such circumstances we see no reason why a cap should apply.

Vera Baird: As the hon. Gentleman said, the clause restates the existing rules in sections 97 and 98 of the 1985 Act, which limit the amount of commission that a company can pay to those who subscribe for its shares to 10 per cent., or such lower amount as may be specified in the articles. Amendments Nos. 528 530 and 528 would relax the provision by removing the 10 per cent. cap, and by allowing commission at any level as long as its payment was authorised by the articles. It would thus create a way round the prohibition on issuing shares at a discount. That prohibition is part of the capital maintenance rules, the purpose of which is to protect creditors. When a company is new, creditors can assume that it has raised at least the value of its nominal capital. Allowing deep discounting, even if that is disguised as a large commission, enables the unscrupulous company promoters to create an empty shell that has the appearance of a well funded company but which in fact is not one. That can be a particular disadvantage for longer-term creditors.
The other amendments in the group would marginally tighten the rules, enabling members to approve a rate of commission that would be effective as a limit if it was smaller than 10 per cent. I am not sure whether that is intended to be an extra element of the authority given to directors under clause 542, but the option of a provision in the articles and a 10 per cent. maximum are, in our view, sufficient. Setting the rate in the articles also has the benefit of increased transparency. Given that explanation, I hope that the hon. Gentleman will withdraw the amendment.

Jonathan Djanogly: I accept the Minister’s explanation, but the purpose of the clause would be to stop unscrupulous companies charging high commissions. As I explained, one could drive a coach and horses through that in any event by charging fees rather than commissions. I feel that my point is still valid, but I hear what the Minister said. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 554 disagreed to.

Clauses 555 to 557 disagreed to.

Clause 558

Alteration of share capital of limited company

Jonathan Djanogly: I beg to move amendment No. 465, in clause558,page268,line37,after ‘capital’, insert
‘or convert shares into shares of a different class provided this does not constitute any variation of rights attached to the shares so converted.’.

Eric Illsley: With this it will be convenient to consider the following amendments: No. 466, in clause558,page269,line27,at end add—
‘(6) Any conversion of rights pursuant to subsection (3)(a) shall not constitute a variation of the rights attached to the shares in question and rights attached to such shares will only be varied in accordance with sections 125 and 125A of the Companies Act 1985 (c. 6).’.
No. 468, in clause564,page272,line12,at end insert 
‘and any other restrictions, whether more or less onerous than the restrictions set out in this section, on the variation of rights.’.
No. 469, in clause564,page272,line27,at end add—
‘(7) Nothing in this section affects a company’s power to vary the rights attaching to shares under section 125(2) of the Companies Act 1985 (c. 6) where the company has already obtained the requisite consent under section 125(2)(a) or convened the general meeting under section 125(2)(b).’.
No. 470, in clause565,page272,line38,at end insert 
‘and to any other restrictions, whether more or less onerous than the restriction specified in this section, on the variation of the rights.’.

Jonathan Djanogly: As we are talking about share capital generally, I should like to point to the statement in clause 557(3) that
“shares may be denominated in different currencies.”
That is certainly helpful. We welcome the reform of authorised share capital, or what one legal commentator called the “tedious fiction”. It has become meaningless, so on its abolition it will not be missed. However, will the Minister explain the transitional arrangements for existing companies—for instance, those whose authorised capital is stated in their memorandum and articles of association? Will that simply be ignored once the Act comes into force, and will companies be required to make changes?
Clause 558 deals with the alteration of the share capital of limited companies, and relates to section 121 of the 1985 Act. That section refers to a company limited by shares or by guarantee, whereas clause 558 refers only to a limited company. Under section 121, a company can alter its share capital in accordance with the section only if so authorised by its articles. Clause 558 does not contain the same restriction or include a provision to cancel shares, as section 121 does.
In debates in the Lords, the Opposition wanted a statutory framework for the conversion of one class of shares into another with the same nominal value. The Government’s view was that the clause does not deal with rights attached to shares but with the level and value of the share capital. The Government did not want a company to allow for the alteration of rights by way of an ordinary resolution, but there was a strong practitioners’ request for a mechanism to convert classes of shares.
The Law Society’s June 2005 paper suggested that there should be a provision for a procedure to convert one class of shares into another in which the nominal value of the shares into which they were converted was greater. The Law Society wanted a mechanism to deal with the difference in nominal value, so that there was no unauthorised reduction in capital.
I appreciate that it is a very technical matter, but it is an important one in practical terms, especially when a company has not been doing well and needs fresh capital. That often initiates a reorganisation of share capital, sometimes with an intake of venture capital. Venture capitalists normally require preferred shares of one form or another, and the share capital problem often arises as a result of the conversion of existing shares. Amendments Nos. 465 and 466 would reflect that by providing that a conversion does not constitute a variation of rights.
Amendments Nos. 468 and 469 deal with clause 564 and the variation of class rights of companies with share capital. Section 125 of the 1985 Act deals with the same issue, saying that the rights attaching to a class of share can be altered in accordance with any provision of the company’s articles. Clause 564 states that there must be at least 75 per cent. agreement between the shareholders within a class before their share rights can be varied. However, it is questionable whether the clause as drafted sets a statutory minimum. Clause 564(3) simply says:
“This is without prejudice to any other restrictions on the variation of the rights.”
There is nothing to say that the restrictions must be more onerous, which seems to be the Government’s intention as stated in the notes to the Bill. Could not such restrictions therefore be less onerous? Furthermore, why did the Government decide to abolish the 1985 Act right to allow class rights to be varied with less than 75 per cent., if the articles so provide, in what we thought was meant to be a deregulatory Bill? Those provisions are reflected in amendments Nos. 468 and 469.
Amendment No. 470 deals with clause 565, which is a more specific addition to section 125 of the 1985 Act relating only to companies with no share capital. The same issues in clause 564 apply here. The Government seem to be trying to introduce a statutory minimum level of agreement between members of the same class. A similar amendment, No. 470, has been tabled to clause 565.

Vera Baird: As the hon. Gentleman said, amendments Nos. 465 and 466 would expressly permit a company to convert its shares from one class to another by passing an ordinary resolution. That is expressed to be subject to the caveat that such a conversion would not amount to a variation of class rights. The driver is clearly a desire to facilitate the re-designation of shares—for example, where a company wants to convert As to Bs—without changing the rights enjoyed by the holders of those shares.
The matter was debated in Grand Committee, and my noble Friend Lord McKenzie subsequently wrote to Lord Hodgson on 2 May 2006. The letter is in the Library of the House, and I expect that the hon. Gentleman has had the opportunity to read it. Having discussed the point with the Law Society, we concluded that what Lord Hodgson described as the conversion of shares from one class to another, which has implications for minority shareholders and is therefore subject to a more restrictive statutory regime than that envisaged by the noble lord, appears to amount to no more than the re-designation of a class of shares.
Section 128(4) of the 1985 Act clearly envisaged a company assigning a name or other designation to any class of shares, as it requires a company to give notice to the registrar. However, the Government do not see the need for the Bill to regulate how the company takes that decision.
Amendments Nos. 468 and 470 concern how class rights may be varied under the Bill. Clauses 564 and 565 will insert new sections 125 and 125A into the 1985 Act to prescribe the minimum requirements for variation of class rights: either the consent in writing of three quarters of the holders of the class or a special resolution of that class. However, if and to the extent that a company has adopted a more onerous regime for the variation of class rights, it must comply with the more onerous regime.
The amendments would enable a company’s members to make provision for less onerous as well as more onerous conditions to apply to variation than those prescribed in statute. Variation of class rights might reduce the relative power of one class of shareholders vis-Ã -vis another, and might amount in the worst-case scenario to a fraud on the minority. That is clearly undesirable, and it is only right that stringent conditions should apply to a proposed variation of class rights.
Amendment No.469 to clause 564 concerns the transitional arrangements that must be made for existing companies that have sanctioned the variation of class rights under section 125 in circumstances in which the variation has not taken effect at the date that the Bill comes into force. As we have said before in Committee, the Bill is not the place to make such transitional arrangements.
Section 125 provides that, in certain circumstances, a variation provision in the articles will prevail, notwithstanding the fact that it is less onerous thanthe statutory regime—and we accept that. The circumstances in which this exception to the general rule applies are constrained under section 125(4) depending on where the rights are attached to the shares—whether in the memorandum or elsewhere—and when the provision with respect to their variation was included in the articles.
It is also understood that companies rarely make use of the current flexibility to have less onerous conditions for a variation of class rights. We therefore took the view that a minimum requirement for a 75 per cent. majority of the class in question should be imposed to simplify the provisions on variation, as recommended by the company law review.

Quentin Davies: On a point of order, Mr. Illsley. I do not wish to be discourteous to the Minister, but she is going through some quite complex stuff and mumbling rapidly into her brief with the sort of diction that one associates with an old-fashioned Roman Catholic priest saying the Tridentine mass. It is quite difficult to follow every word, but each word may have some significance. Through you, Mr. Illsley, would it be possible to ask the hon. and learned Lady to lift her voice and enunciate her words a little more clearly?

Eric Illsley: That is not technically a point of order, but I am sure that the Minister will have heard the hon. Gentleman’s comments.

Vera Baird: I have never been accused of having a soft voice or of being anything other than a person who projects themselves well. I am not speaking in Latin, in which the Tridentine mass is recited. So I will open my mouth, the hon. Gentleman will open his ears and we will get on amazingly well, as we have before. Does he want me to go over anything?

Quentin Davies: No.

Vera Baird: I will try to accommodate the hon. Gentleman.

Crispin Blunt: Translation is an issue.

Vera Baird: I am sure that the Bill team could provide briefing in Latin if we asked them, if that would add to the entertainment of this final day. The hon. Gentleman is testing fate because I understand that we have a PhD in Greek on the team who is even now working to make life more complicated.
On the point raised by the hon. Member for Huntingdon (Mr. Djanogly) about share capital in clause 557(3) and transitional arrangements, we hope shortly to put out a consultation paper on those arrangements, to set a general approach, and we will then will consult in more detail on draft regulations after Royal Assent. I hope that that satisfies the hon. Gentleman on that point.

Jonathan Djanogly: I thank the Minister for her reply. As this is the last day in Committee, we can move on. However, as my hon. Friend the Member for Grantham and Stamford (Mr. Davies) rightly said, those are complicated provisions. To that extent, we will wish to have a careful look over the summer at what the Minister has said and reserve our position until proceedings on Report. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 558 disagreed to.

Clause 559 disagreed to.

Clause 560

Notice to registrar of sub-division or consolidation

Jonathan Djanogly: I beg to move amendment No. 467, in clause560,page270,line14,after ‘up’, insert ‘or treated as paid up’.
The clause deals with notice to the registrar of sub-division or consolidation. It relates to section 122 of the 1985 Act. Under the notice provision of section 123 of the 1985 Act, there is no requirement for a company to file a statement of capital. The aim of the amendment, which comes from the Law Society, is to have the fact that any share capital following reorganisations that is to be treated as paid up should be recognised on the form. Would it not be possible to comply with the related company law directive, 77/91/EC, by giving a short, specific notification at the time and then combining a full return with the annual return?

Vera Baird: The amendment relates to information that is to be stated in the statement of capital to be filed following the subdivision or consolidation of share capital, and seeks to make it clear that paid up includes amounts treated as paid up. That distinction is currently drawn in section 88 of the 1985 Act.
We take the approach that it is unnecessary in the context of the statement of capital to draw a distinction between amounts paid up and amounts treated as paid up. The reference in clause 560(3)(d) to amounts paid up is, therefore, intended to apply not only to amounts paid up in cash but to amounts paid up by the transfer to the company of a consideration other than cash. I hope that that clarification is sufficient for the hon. Gentleman to think that the proposed amendment is unnecessary.

Jonathan Djanogly: I hear what the Minister says. It is a difference in approach, and I do not wish to pursue it, so I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 560 disagreed to.

Clauses 561 to 569 disagreed to.

Clause 570

Circumstances in which companies may reduce share capital

Quentin Davies: I beg to move amendment No. 357, in clause570,page275,line22,leave out ‘private’.

Eric Illsley: With this it will be convenient totake the following: Amendment No. 358, in clause571,page276,line8,leave out ‘private’.
Amendment No. 461, in clause580,page286,line15,leave out ‘private’.
New Clause 437—Distribution out of company share premium account (No. 2)—
‘(1) Section 263 of the Companies Act 1985 is amended as follows.
(2) In subsection (1) after “purpose” insert “except as provided for in section 263(6)”.
(3) After subsection (5) add—
“(6) A company may make a distribution out of the company’s share premium account provided that—
(a) the directors certify that the proposed distribution in its totality amounts to less than the operating cash flow minus depreciation defined as—
where—
S is sales,
CGS is the cost of goods sold,
G+A is general and administration expenses,
NI is the net interest charge,
T is the tax charge,
WCR is the working capital requirement, and
D is the depreciation charge of the company in the relevantyear; and
(b) the directors have made a solvency statement in accordance with section 135B of the Companies Act 1985.”.’.

Quentin Davies: It would be remiss of the Committee to pass new company legislation without considering in detail two important matters. One is a theoretical problem of long standing, an issue of principle that underlies not only this clause but a number of others. The other is a very practical problem in relation to which people outside this place will look to Parliament to produce a solution. In the two amendments and the new clause I am trying to bring together both those problems with a view to trying to solve the practical one.
The theoretical problem concerns what constitutes equity capital, and to what extent equity capital should constrain the payment of dividends. Although it is theoretical, it has enormous practical significance and it relates directly to this clause, which deals with the ability of companies to reduce their capital.
All Committee members with business experience will have been brought up with the notion that equity capital, shareholders’ funds and net worth are all equivalent expressions. It is divisible into four categories: paid-in nominal share capital, the share premium account, reserves and the profit and loss account. We were all also brought up on the principle that dividends are paid only out of reserves or those reserves that are distributable—I do not have time to go into the distinction between distributable and non-distributable reserves—or the profit and loss and account, in other words the current profit for the year. 
Paying a dividend out of reserves is an exceptional thing to do. It requires some justification and explanation. It would be deeply shocking to pay dividends out of any other aspect of capital, out of the share premium account or out of nominal share capital. That is a principle that everyone has been brought up on and I am not sure that everybody has thought it through very clearly.
If one thinks about it—we owe it to ourselves and others to think about it quite carefully—these distinctions make no conceptual sense and no economic sense either. They are merely semantic distinctions. They are a matter of the conventional use of language. It actually does not matter at all whether a company issues a million shares at £1 at par and then has a nominal share capital of £1 million and no share premium account or whether it issues 500,000 shares at £2 and ends up with £500,000 of nominal share capital and £500,000 of share premium account. It makes no economic difference at all.
Let me go further. It actually makes no economic difference whether a company retains a substantial amount of its earnings, or perhaps all its earnings, and never pays a dividend and thereby accumulates substantial reserves, but maybe has no share premium account as all it did initially was to issue its shares at par and it has never raised share capital since and is entirely dependent upon retained profits for its increase in shareholder funds, or whether a company has done the exact reverse.
By doing the exact reverse, the company would have distributed a large proportion of its profits by way of dividend and then, from time to time, when it needed to replenish its share capital, issued rights issues. In that case it would have a substantial share premium account because it would not have been able to go to the market successively to raise capital in that way unless the share price had performed well and gone well above the par value. It would have a substantial share premium account and perhaps small reserves. It has absolutely no significance in terms of the value of the company and its operations which of those two options the company chose.
Let us take a company that has been around for 100 years. I cannot think of one offhand but I can think of companies that have been public-quoted companies for 80 years, such as BP or what remains of ICI. Who cares whether in 1938 or 1953 BP or ICI did a rights issue or whether at that stage in their life they retained a large amount of their earnings? It is not even a matter of historical interest as the phrase “historical interest” implies some causal significance. It is a matter of merely antiquarian curiosity at best.
If that is the case, we have to look again at the whole issue of the extent to which the payment of dividends should be restrained not by share capital as a whole, but by the amounts of specific share capital that are defined as being nominal capital or share premium account or reserves or whatever. Of course, equity capital as a whole is extremely important. The total to which those four categories amount is extremely important in the life of a company, but the artificial categories into which the equity capital is traditionally divided are not. In fact, the only economic interest is twofold: in a company’s total equity capital in relation to its financial liabilities—in other words, its gearing and financial risk, which we all know is important—and in its equity capital in relation to its trading risks. We all know that a well-managed company will match and balance the two. If a company has, by the nature of its activities, a high degree of trading risk and a high volatility of earnings, it would be wrong for it to add financial risk to that operational risk through high leverage. If, on the other hand, a company has a very low volatility of earnings, it may be not only responsible but desirable for it to increase its debt to bring the weighted average cost of capital down to the minimum level. The total amount of equity capital is enormously important, but the rather curious distinctions that we traditionally make are of no importance whatever.
The second matter that I wish to raise is a practical problem that we must address. Under the European directive—I think that it is the fourth accounting directive, but someone will correct me if I am wrong, for instance my hon. Friend the Member for Putney (Justine Greening), who is an expert on such matters—international financial reporting standards have been introduced throughout the European Union for all quoted companies in their consolidated accounts. That came in last year, so this year is the first in which every such company has had to produce consolidated accounts according to IFRS. Some of them will have been doing so for a year or two. The provision applies only to consolidated accounts of quoted companies.
IFRS is a form of so-called true value accounting. In other words, it is intended to show the real value of a company much more accurately than did previous general accounting principles. It therefore requires that companies mark to market their liabilities and assets, including derivative liabilities and assets—derivative finance may be an asset or a liability, depending on whether a company is in the money. Companies must market, for example, non-realised real estate assets that might previously have been carried at historic costs with some adjustments. Importantly, it also requires companies to market long-term liabilities such as pension liabilities. It is no longer possible for companies to understate or smooth those liabilities, as they could under the previous system of general accounting principles.
The effect of IFRS, true value accounting, marking to market and the full force of the provisions is an inevitable increase in the volatility of a company’s earnings. They also have the effect, of which public companies are conscious, of an increase in the risks and volatility of earnings derived from factors beyond the control of a company’s directors. It is often beyond the ability of directors to make clear and comfortable predictions about the risks involved. Such risks can be, for instance, an actuary’s decision to revalue a pension deficit or what happens in the markets to the value of derivative liabilities or assets carried in a company’s balance sheet, and they can be difficult to predict. In many cases such volatility has meant that a company with constant or growing trading earnings from its normal operations has found itself unable to pay a dividend from its profit and loss account because that account has been wiped out by the provisions in question.
The second aspect of IFRS is that it has involved the introduction of new, much stricter rules in the important matter of taking profits out of acquisitions. Pre-acquisition profits must be accounted for as a reduction in the net cost of an acquisition rather than as a dividend from the company concerned. I do not want to go into the merits or demerits of that. Some interesting intellectual arguments can always be had about all those accounting rules and conventions. That is a fact; it is the way in which IFRS has determined that one should account for profits of acquired subsidiaries. That again substantially reduces the ability of certain companies to show profits from those dividends and therefore to declare a dividend.
It is extremely undesirable that companies should, as a result merely of the change in accounting standards, have to change their distribution policy, in other words that they should have to decide that they can no longer pursue what they otherwise would pursue by way ofa pay-out of dividend, whether by use of a dividend, a share-buying programme or other ways of giving a current return to shareholders. Why is it undesirable? It is undesirable in principle because it reduces capital mobility in the economy and is likely over time to reduce the average return on capital employed in the economy, which is a serious matter for us all. It is undesirable for certain types of shareholder, such as investment trusts, which can pay out by way of dividends only what they receive by way of dividends, and, indeed, pension funds, which require dividends in order to pay pensions. We have every interest, I think, in maintaining the viability of pension funds to the extent to which we can as they have faced a lot of threats, challenges and handicaps in the past few years, as we all know. I do not need to go into that.
The application of IFRS is introducing a degree of artificiality. I do not wish to challenge IFRS, as much of it is well conceived. I most certainly do not wish to challenge the EU accounting directors, because it is highly desirable that we should have the same rules and playing field throughout the single market. It is very important for the operation of the single market and the integrity, comprehensibility and transparency of our financial markets that that should be the case.
We face a practical problem. Over the past year or two, companies facing that problem have been able to find a particular way round it. The directive in question—I see that my hon. Friend the Member for Putney has come back and perhaps she can remind me whether it is the fourth directive—to which I have already referred, provides that from this year public quoted companies must present their consolidated accounts according to IFRS. They do not have currently to present their subsidiary accounts, including their holding company accounts, according to IFRS. They will have to do that in three years’ time, in 2009, in relation to the 2008 trading year. I believe that that is the year in which it will come in.
That means, since it is not the consolidated companies, or the consolidated group, but the holding company that pays the dividend, that it has been possible for companies to continue to account in their subsidiaries and their holding company according to the previous generally accepted accounting principles, or GAAP, and then to present their consolidated accounts according to IFRS. Within the area covered by GAAP, they simply have their subsidiary companies declare dividends, pass them up the chain to the holding company and the holding company decides to declare a dividend to shareholders on the basis of the stream of dividends that it has itself received from the operating subsidiaries of the group. One might say that that is fine, but there are two problems.
First, I do not think that any of us should be satisfied with a situation in which companies essentially account according to two different sets of principles within the same group. There cannot be good transparency and it is impossible for shareholders to follow what is going on because they cannot relate the dividend that they receive, which is related to the holding company’s profit, to the profit that appears in the consolidated accounts that they are sent. That is an undesirable situation in the first place.
Secondly, such accounting is expensive, particularly in this country where, unfortunately, companies have to produce a separate set of accounts for the Revenue. Essentially, companies will undergo the costs of preparing in parallel three different sets of accounts according to different accounting principles—as we know, the Revenue has its own accounting principles, with taxable profit defined separately from accounting profit. Of course the change will be good for the accounting profession and I will lose a few friends in that profession by saying this, no doubt, but I do not believe that it can be in the country’s interest to impose statutory levels of additional, gratuitous and unnecessary compliance costs on companies that have that particular system.
The other problem with that solution is that it is coming to an end. The party is coming to an end—we are going to run into the bumpers in three years’ time, and companies will quite rightly no longer be able to account according to different principles in their operating subsidiaries and holding companies. They will have to apply IFRS throughout the groups.
How will dividends be paid out in those circumstances? That is the practical problem. There is also the philosophical problem—the problem of the principal, and the problem of the definition of equity capital and of the extent and modalities according to which it should define the ability of a company to pay a dividend. The practical problem is the problem imposed by the introduction of IFRS on companies continuing to pay dividends at the present time.
I brought those two problems together and produced two separate solutions. One solution is included in my amendments Nos. 357 and 358, and a quite different one is set out in my new clause 437. Even if we were not in the peculiar situation of everybody voting against their own clauses, I would still not put amendments Nos. 357 and 358 to a vote, for reasons that I will explain. However, they would provide a solution, in the sense that they would permit public and private companies, as well as quoted and unquoted companies, to pay dividends out of their capital, provided that the directors made a solvency statement in accordance with clauses 570 and 571.
That would solve the problem. In that situation, the directors could decide what would be a responsible level of payout to make to their shareholders. They could make that payment as long as the money was there, whether it was in a share premium, reserves, a nominal capital or a profit and loss account. The money could all come out of the equity capital, in which case the directors would have to make the statement as set out clause 571 as it is, in which they say that the company, having paid that money out, will nevertheless be able to meet its debts and remain as a going concern for 12 months.
Is that a solution? Well, it is a theoretical solution, which we have to consider, and that is why I brought it forward in the way I did. However, I will not put the amendment to the vote, and if anybody else did so, I would vote against it. I shall explain why. The solution is not adequate, nor is it right. I would not follow it if I was a director of a company, as it is not sufficiently prudent. The solvency statement provides that the directors take the view that the company can continue to meet its liabilities for the following 12 months, which might give some comfort to the creditors. Of course, it is not reasonable to expect directors to take a view beyond that period.
I can see why the solvency statement is defined as it is in both the 1985 Act and the Bill, but it does not provide a responsible way to manage a company. There is no concept at all of the sustainability of the company or of the company retaining the resources required to ensure that it has the capacity to create value in the future, which is a short-termist concept. What happens after 12 months? Who cares what happens after 12 months? That kind of attitude is not acceptable. No responsible company director would want to declare a dividend in normal circumstances in that situation. If a company was going to be wound up—part of clause 571 provides for that eventuality—different considerations would apply.
The proposed solution is therefore not satisfactory from that point of view, and it is not legally possible in any case, because it would conflict with the second company law directive, which says that companies cannot pay dividends out of their share capital, which the jurisprudence interprets as nominal share capital. I am therefore not putting forward that solution.
Having rejected that solution, I had to think of a better one, which is set out in new clause 437. At first sight it might look complicated, but it is not complicated at all. I simply propose that, in so far as a company pays a dividend out of its operating cash flow—that is, its cash flow from trading operations—after depreciation, so that it takes account of the need to renew its existing fixed or other assets and maintain them at least at the same level of productive capacity, that company can pay a dividend to shareholders out of the remaining sum. I define that in what is actually a simple linear equation, although it might look slightly intimidating. I only do linear equations; I do not do differentials. Such things are not difficult to follow.
I have set out a standard definition of operating cash flow: sales amounts costed with sales, minus general administrative expenses, minus the interest and tax charges, minus the difference in the working capital requirement. Anybody can know what those quantities amount to for any company, because they are all declared in the profit and loss account. If there were changes to the working capital requirement, two successive balance sheets would be required. That is simple. One takes the sum of those calculations—a company’s operating cash flow—and then provides for the depreciation charge. An accountant may say, “I am mixing cash-flow quantities with an accruals item and I should not be doing that. But I am deliberately doing so, because I am taking the operating cash flow and saying that one provision that a company must make is to renew its capital equipment and keep going as a capital concern.” A company may be investing in addition to the depreciation charge, which is normally healthy. That is fine; it can borrow or raise new equity capital for that purpose, because that is outside the operating cash flow area.
I take the operating cash flow, minus the depreciation charge, which could be defined as the operating profit, and say that a company can responsibly pay a dividend out of that. However, it is fine if that eats into the capital and reserves—currently regarded as non-distributable—or into the share premium account. I understand that that situation applies elsewhere in the European Union. The second company law directive has been interpreted elsewhere—certainly, in France—to allow companies to pay a dividend out of the share premium account.
We have a proposal that stands up in terms of financial theory and good business practice and also stands up against the current requirements of EU law. That is my contribution to resolving this problem.

Jonathan Djanogly: My hon. Friend spoke eloquently about what he believes to be the relevance of the share premium account and the UK anti-capital reduction laws. I have some sympathy with what he said, although his amendments deal with rather more specific points than the overall share capital laws. If we were to consider this matter in more detail, we would need a full debate on the value of the share premium account, which he came round to in his closing remarks.
Perhaps something happened during the consultation at some point; I should be interested to hear if that was so. However, today we are considering whether a public company should have the same carve-outs from the protection of capital rules that a private company current has. That applies to my hon. Friend’s amendments Nos. 357 and 358 in relation to the reduction of share capital and to the amendment tabled in my name and the names of my hon. Friends the Members for Reigate (Mr. Blunt) and for Hornchurch (James Brokenshire), dealing with the power of a company to redeem or purchase the same shares out of capital.
These probing amendments are useful in finding out the extent to which the Government reviewed the existing law in introducing the relevant clauses. If a public company undertook a statutory declaration and the resolution and complied with all the other requirements, why should it not be permitted to do the same as a private company?

Vera Baird: The hon. Member for Grantham and Stamford advanced an excellent and hugely impressive analysis. First, on his new clause 437, he advanced an issue of principle, or a theoretical problem, by asking what equity capital is and how it should constrain the payment of dividends. We acknowledge that the distinction between nominal share capital, share premium account, equity reserves and so on, does not make a great deal of conceptual sense. The hon. Gentleman puts forward an arguable case and is right to say that that complex matter requires more thought.
As the hon. Gentleman rightly said, our public arrangements are constrained by Europe, which makes it difficult to propose radical reform. We do not think it would be right to make piecemeal reform of the kind proposed here. In essence, that is why we want to take the powers proposed later in the Bill. That will allow for a good deal of further thought on that complicated analysis, and for broader reforms, rather than piecemeal ones such as those proposed here.

Quentin Davies: I am most grateful for those kind remarks about my suggestions, but the remedy that the Minister is proposing is not satisfactory. In relation to the matters I have raised this morning, how can we have a serious discussion in a statutory instrument Committee on to which people are press ganged at the last moment and without preparation, that has a time constraint and in which no one can propose amendments? Such parliamentary scrutiny is an affront to democracy—it happens every day and, frankly, it is a scandal. She is suggesting that those complex issues, on which she acknowledges the importance of preserving real discussion and debate, should be treated in such a dismissive fashion.

Vera Baird: It is not dismissive and it is folly to make such a fuss about a procedure that has been used for an extraordinarily long time. I have cogent views on how statutory instruments are taken through the House. The point has less to do with the procedure and more with the consultation that comes before it.
I was seeking to indicate that the hon. Gentleman has put forward a complex and persuasive case—indeed, at one time he almost persuaded me to accept the amendments that he then was not sure would suffice. I cannot overestimate the extent to which he has made a persuasive case for having a close look at those two issues. This is a question not of procedure, but of having help to alert us to the need for a further look at those matters and the consultation that will follow, which will be substantial.
Of course, we looked at those issues in the company law review and, realistically, that is as much as I can say about new clause 437. It is, on the face of it, a cogent proposal to address the theoretical criticisms and problems that the hon. Gentleman presented, but we are not satisfied that thought has gone into it sufficient for us to accede to his request.
As I said, the hon. Gentleman persuaded me practically that his amendments Nos. 357 and 358 meet what I think he referred to as the “practical problem”—we acknowledge, the potentially major problem—but there is no easy solution. Clearly, the detail and complexity of his analysis and his obvious experience and expertise led him to believe that the two amendments would meet that problem. The fact that he now argues away from them—for a second time, convincingly—demonstrates the immense complexity of the matter that he rightly raised.
We need to look at that matter, although there is no simple solution, as I said. If the hon. Gentleman is prepared to assist us to reach a better solution than even he has yet arrived at, we would be immensely grateful. However, I think he can appreciate, from the generous—not overgenerous—way in which I addressed his arguments, that we take the point that this is a major issue requiring further thought.
Altogether simpler to deal with is the question that the hon. Member for Huntingdon asked about the extent to which we have considered the import of the amendments tabled by the hon. Member for Grantham and Stamford, those being about the extension to public companies of the solvency statement preceding a capital reduction, which would mean that they did not have to apply to court to reduce their share capital.

Jonathan Djanogly: On the conclusion of the Minister’s remarks on the point made by my hon. Friend, is she saying that she intends to initiate such a review?

Vera Baird: I shall carry on dealing with those points, if I may, and find out the procedure that we intend to follow, having acknowledged that the point is serious.
On the point about extension of solvency statements to public companies, the company law review recommended that the solvency statement procedure for capital reduction should be available, and we developed that recommendation in the 2002 White Paper, “Modernising Company Law”. However, to meet unavoidable EU requirements that apply to reduction of capital by public companies, it would have been necessary to build substantial additional safeguards into the procedure. In particular, it would have been necessary to give creditors of public companies the right to object to the court. The proposed procedure would therefore of necessity have been significantly more complicated than that for private companies.
The response to the consultation was mixed. Although many respondents were in favour of simplifying the procedure for capital reductions for public companies, it was felt that the required additional safeguards would make the solvency statement procedure significantly less attractive and that very few public companies would be likely to want to use the procedure.

Jonathan Djanogly: Is that because the procedure applicable to private companies, combined with the requirement to go to court, would have been more complicated than the existing system for public companies, which involves going to court anyway?

Vera Baird: Yes. It seemed that there was not much of an advantage, given that the issue would be bound to end up in court. The Government therefore concluded that there would be little point in extending the solvency statement procedure for capital reductions to public companies.
To return to the question whether the Government intend to initiate a review on the point raised by the hon. Member for Grantham and Stamford, we will have further discussions with interested parties. In light of those discussions, the European position, and the international accounting laws to which the hon. Gentleman referred, we shall look keenly for a solution to what are complex problems. I acknowledge that the problems have not been solved by this discussion, but they have been expanded on and elucidated—certainly for me. We shall proceed as I have indicated and I invite the hon. Gentleman not to press the amendment.

Quentin Davies: I am certainly grateful for the Minister’s kind and, more importantly, considered and reflective response. I am delighted that she will now be launching a discussion and a consultation. If the remark that she made just now was an invitation to participate in such a consultation—other than in the context of a statutory instrument Committee, which I consider an insulting waste of time for any parliamentarian on any subject, particularly a complicated one like this—I would be delighted to do so. In any event, in light of the Government’s response, I shall not press the amendment.

Jonathan Djanogly: I am impressed with the Minister’s response and her offer of further consultation will be well received. I understand and agree with what she said about procedures for public companies being more complicated if the amendments were made.

Quentin Davies: I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 570 disagreed to.

Clauses 571 to 573 disagreed to.

Clause 574

Financial assistance by company for acquisition of shares

Jonathan Djanogly: I beg to move amendment No. 349, in clause574,page279,line30,after ‘person’, insert
‘(other than the company itself)’.

Eric Illsley: With this it will be convenient to discuss the following amendments: No. 350, in clause574,page279,line35,after ‘person’, insert
‘(other than the company itself)’.
No. 351, in clause574,page280,line18,after ‘person’, insert
‘(other than the company itself)’.
No. 352, in clause574,page280,line24,after ‘person’, insert
‘(other than the company itself)’.
No. 353, in schedule16,page543,line30,at end insert
‘in section 153(3)(d), the words “or purchase”.’.

Jonathan Djanogly: We come to the provisions on financial assistance. As every practitioner will know, this is one of the more complex and difficult provisions in the 1985 Act. It is the bugbear of many a corporate lawyer, and causes bewilderment to many a company. The basic premise of the Government’s approach is therefore welcome.
Clause 574 will replace section 151 of the 1985 Act with proposed new sections 151 and 151A—I presume that those numbers will change on consolidation. The prohibition on the giving of financial assistance by private companies for the purchase of shares is to be abolished. Proposed new section 151(1) retains the prohibition on public companies giving financial assistance, and extends the provision on post-acquisition assistance. The latter is prohibited for public companies if they are public at the time the assistance is given. That will be hugely welcomed by companies and practitioners, who have to spend a lot of time dealing with such matters.
The amendments, which were suggested by the Law Society, are designed to make it clear that the financial assistance rules do not apply to the purchase by a company of its own shares on the basis that a statutory regime applying capital maintenance to the purchase of own shares already exists.
The prevailing legal view is that the financial assistance rules do not apply to the purchase of own shares, but although section 155(3)(d) of the 1985 Act provides specifically that section 151 does not prohibit the redemption or purchase of shares in accordance with that Act, there is some doubt, reinforced by comments made in the Chaston case, as to whether the financial assistance rules have no application in those circumstances, or whether anything done for the purpose of enabling a purchase of own shares to take place might nevertheless contravene the financial assistance rules.
A typical example is when, to finance the purchase of own shares, a company borrows money or gives security. Considerable additional legal costs and expenses are being incurred by companies and their financiers on that point.

Vera Baird: The prohibition is on the giving of financial assistance to a person acquiring shares in a company when the financial assistance in question is by the company. The amendments would mean that references to “person” did not include the company, and anything that the company did to buy back its own shares would therefore not constitute unlawful financial assistance.
The hon. Gentleman has acknowledged the predominant view, which is that construing references to “person” to include the company is not commonly accepted. It is at odds with article 23 of the second directive, implemented by section 151, which envisages a “person” as being a third party. In our view, references to “person” do not include the company itself.
The hon. Gentleman might say that we should put the matter beyond doubt by accepting the amendments, but he, like all lawyers, knows the risk of amending existing statutory provisions; it implies that the existing provisions meant something else—for instance, that references to “person” included the company before the change occurred. In the long run, that might lead to more difficulties.
Amendment No. 353 is consequential to the other amendments, so I shall not argue them separately. I hope that the hon. Gentleman agrees that the proposed change is unnecessary and the ever-present danger that I have pointed out makes it undesirable.
The hon. Gentleman will be amused to hear that I have read the case of Chaston—the first company law case that I have read since I was a 19-year-old undergraduate. I am massively impressed by the learned reasoning of Lady Justice Arden, who seems to be the ultimate company lawyer. If it is helpful—I know that the case was raised in the Law Society’s submission—I shall do my best to take him through what I have concluded her paragraph 47 refers to. I have been immensely assisted by the advice of officials. 
Paragraph 47 of the judgment of Lady Justice Arden on Chaston v. SWP Group plc could appear to contemplate that a company could provide assistance to itself. It has to be read in context. Lady Justice Arden explains why the reasoning of Mr. Justice Davis in paragraph 14 of Chaston—he referred to it as the second reason for his finding—which Lady Justice Arden and her colleagues were overturning was wrong or too strongly expressed. Mr. Justice Davis, the first instance judge, had pointed to the words “by that or another person” in section 151(2) in support of his view that a liability incurred bona fide in what the directors believed was the best interests of the company was not directly or indirectly for the purpose of acquisition of its shares. With respect to the learned judge at first instance, that seems to be an over-broad view to take. Lady Justice Arden points out that if Mr. Justice Davis’ construction—that the liability being referred to could not be that of the company—was correct, it would have the result that even liabilities incurred by the directors in the name of the company in breach of duty would be outside the reach of section 151. That would be both undesirable and nonsensical, so she shows that the reasoning of Mr. Justice Davis was defective by going beyond what was needed for his finding.
Having conceded the possibility that, as a matter of statutory construction, “person” in section 151(2) could include the company—we have already argued that for reasons of consistency with EU law that is not the way in which it should be read—Lady Justice Arden goes on to refer to the grant of a security by an unlimited company. She contextualises it pretty effectively in paragraph 47 of her judgment, in which she says, referring to the first instance judge:
“The judge’s second reason was based on section 151(2). I agree it would be an unusual case where a company provides assistance to itself. On the other hand, it is possible that an acquisition of shares may be an acquisition of shares by the company itself.”
She compares the use of the word acquire in that instance to its use in other sections of the 1985 Act and continues,
“In those circumstances, the liability referred to in the opening clause of section 151(2) may be a liability incurred by the company itself in order to purchase shares in itself, for example, the grant of security by an unlimited company to secure a borrowing raised to purchase its own shares.”
Of course, unlimited companies are not subject to the general prohibition on companies acquiring their own shares and it follows that there is no need for unlimited companies to be subject to the special rules enabling limited companies to purchase their own shares in particular circumstances. If Lady Justice Arden thought that a purchase of own shares in accordance with the special rules applying to limited companies could fall foul of section 151, there would have been no reason for her, extraordinarily, to refer to unlimited companies, which are relatively rare and are not subject to those rules at all. She seems to have set up an argument in order to show that Mr. Justice Davies was wrong and then posited very unusual circumstances—the only way in which her argument could apply. She sets the case up only to undermine it and knock it down; at the same time she very successfully demonstrates the flaw in Mr. Justice Davies’s argument. It seems pretty clear to us, although it is a complicated process of reading and following to arrive at it, that the hon. Gentleman has nothing whatever to worry about.

Jonathan Djanogly: I thank the Minister for that very comprehensive response. I find her arguments very convincing. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Jonathan Djanogly: I beg to move amendment No. 354, in clause574,page279,line31,after ‘subsidiaries’, insert
‘incorporated in the United Kingdom’.

Eric Illsley: With this it will be convenient to discuss amendment No. 355, in clause574,page279,line39, after ‘subsidiaries’, insert
‘incorporated in the United Kingdom’.

Jonathan Djanogly: The purpose of the amendment is to make it clear that the prohibition does not apply to financial assistance given by a foreign subsidiary of a UK company. The amendment is designed to give statutory effect to the decision in Arab Bank plcv. Mercantile Holdings Ltd 1994 in which it was held that the statutory prohibition on a company giving financial assistance for the purpose of acquiring shares in the company or its holding company does not apply to the giving of assistance by a subsidiary incorporated in an overseas jurisdiction to a person acquiring shares in its British parent company, not least because we are now revising the law and would not wish to leave room for this to be interpreted again. It would be helpful if the decision were reflected in the statute. The textbooks have that position as stated law and the amendment is a belt-and-braces provision.

Vera Baird: We agree. If the hon. Gentleman would be kind enough to withdraw his amendment, we intend to look at the matter again and, in the context of the restatement exercise over the summer, to do what we can to address the problem.

Jonathan Djanogly: I am grateful for that response. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Jonathan Djanogly: I beg to move amendment No. 471, in clause574,page280,leave out lines 6 to 15.

Eric Illsley: With this it will be convenient to discuss amendment No. 472, in clause574,page280,line11,leave out ‘twelve’ and insert ‘six’.

Jonathan Djanogly: The purpose of the amendment is, first, to query the appropriateness of criminal sanctions for offences under the clause. I thought that there were proposals to change them to civil penalties. It would be helpful if the Minister told us how many criminal charges there have been in this respect. I imagine it is not many. Secondly, if the offences are to remain criminal offences, why is the sentence half as long if the crime is committed in Scotland?

Vera Baird: Amendment No. 471 would completely remove the penalty that attaches to the offence of a public company providing prohibited financial assistance. Obviously it would be pointless to say that something is unlawful if there is no sanction for doing it. Should the penalty be imprisonment or some lesser penalty? We believe that a constraint must be kept for public companies and that it would be most effective if associated with a criminal penalty at the proposed level.
The hon. Gentleman is asking why the offence is a criminal offence, but I think that I have summed up our view. Comment has been made on proportionality in relation to the law reforms that we are making. The Hampton review and the company law review considered decriminalising some regulatory offences and giving greater emphasis to administrative penalties. However, consultation and evaluation found that the use of criminal offences was the more proportionate and efficient way to enforce regulatory requirements. Offences are less likely to be committed if they are backed up by criminal penalties. Criminal sanctions are appropriate, proportionate and essential for effective enforcement of breaches, but the underlying threat of prosecution enables authorities to exercise a progressive approach to enforcement that secures compliance without prosecution. The element of criminality behind the provision enables that approach.

It being twenty-five minutes past Ten o’clock,The Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Twelve o’clock.